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Pepsi Gains Toehold in Coke Stronghold

By Offering Both in Pilot, McDonald's Could Tip Scales in Cola Wars

CHICAGO (AdAge.com) -- The new ground zero in the beverage wars: McDonald's. While restaurants traditionally sell either Coca-Cola or Pepsi-Cola, the burger

McDonald's 10-month-old pilot project offers Pepsi products where once only Coke could be had. Sales through McDonald's restaurants account for as much as 10% of Coke's North American profit.

baron is breaking new ground by testing a program that allows consumers to choose among brands from both companies at some outlets. The 10-month-old initiative is doing so well it's being expanded to at least one new market -- Wichita, Kan. -- and should it go national, it could tip the balance in the beverage wars and finally give Pepsi the winning hand.

Freedom of choice
"Where consumers have freedom of choice, like they do in [convenience] stores, that's where you see Pepsi have a lead," said one executive with long ties to Coke. "It's fountain that tips the scales for Coke, and it's McDonald's that tips the fountain scale."

McDonald's test does not put Pepsi brands on its fountains; instead it offers Pepsi products in bottles and cans only at the participating restaurants. But the potential is still there to chip away at Coke's fountain sales at the chain if consumers -- as they often do -- opt to go with the bottled or canned Pepsi products instead.

In fact, the executive speculated that should McDonald's take the program national, it would take only 90 days to see Coke volume freefall.

'Beginning of the end'
"This to me is the beginning of the end," he said, estimating that McDonald's contributes as much as 10% of Coke's North American profit. If "10% of your cash flow in North America [flips] from Coke to Pepsi," the executive said, Coke's share leadership "will unravel. That's what c-stores have already found out."

McDonald's began its test in the Texas cities of Bryan and College Station in May and expanded to Kansas City, Mo., in July. Results have been encouraging enough to expand to additional markets with advertising planned for this summer, according to three executives close to the situation. (Publicis Groupe's Arc is handling in-store displays for the Kansas City test). McDonald's declined to comment on where the test -- led by Karen Wells, VP-strategy at McDonald's USA, and Bill Lamar Jr., senior VP-chief marketing officer -- is going to expand.

Coke currently dominates the fountain, and McDonald's is avoiding a cola war by putting Pepsi brands such as Mountain Dew, Gatorade Propel Fitness Water and Lipton Tea in McDonald's stores but keeping Pepsi and Diet Pepsi out. Coca-Cola controls 42.9% of beverage sales in all domestic channels, followed by PepsiCo's 31.2% and Cadbury Schweppes' 14.9%, according to Beverage Digest. Much of that lead is driven by fountain sales, where Coke controls 70% of the channel and gets a third of its domestic sales and profit. Pepsi, meanwhile, has only 20% of fountain sales.

Take-home channels
But in all four take-home channels (supermarkets, drug chains, convenience stores and mass merchants excluding Wal-Mart), Coke and Pepsi run almost neck and neck, with 35.9% and 34.5% shares, respectively.

Some 25 million gallons of Coke's fountain volume is sold at Burger King each year, according to an industry executive. In the recent past, McDonald's domestic volume was more than three times that and possibly more than 100 million gallons today. The executive said that if PepsiCo's Gatorade were put on the fountain, it could easily sell more than 30 million gallons annually, making it Pepsi's biggest fountain account.

Making the competition even keener is the fact that carbonated soft drinks have declined two years in a row, with the latest year volume down 1.1% to 1.5%, according to two industry reports. Aside from energy drinks, Pepsi brands lead all the fastest-growing segments, including water, sports drinks, and ready-to-drink teas and coffees. With consumer choice accelerating the decline of carbonated soft drinks as other beverages grow and Coke's innovation programs performing sluggishly of late, Coke's foothold has become increasingly vulnerable. But there's also the fact that "restaurants don't want to be in the [single-serve] business," said BevMark president Tom Pirko, adding that fountain is four to five times more profitable than the bottles and cans McDonald's is now testing. "The fountain system is pure gold. They have no choice. If they don't do it, they lose business."

Specific returns data
So far, nobody has been willing to share specific returns, but even if it were expanded, say, to all of of McDonald's company-owned stores, that would would represent only about 15% of its 13,774 domestic units.

"It's all about giving people more choices, particularly when it comes to product variety, portability, and health and wellness," said a Pepsi-Cola North America spokesman in a written statement. "We're pleased to be working with McDonald's, and we hope consumers respond favorably to this test."

Despite the expanding cracks in the relationship, McDonald's executives have been steadfast that, no matter what, its partnership with Coke that began in 1955 will continue. "We value our relationship with Coke," a McDonald's spokesman said. "They are a preferred beverage supplier." But going from the exclusive supplier to a "preferred" one is hardly the testimonial it used to be.